New president to inherit economy from hell

November 4, 2008 12:02:30 PM PST
The next U.S. president will face the worst economic crisis the country has experienced since the Great Depression of the 1930s. What began with the explosion of the housing bubble has unfolded into a far-reaching global financial crisis affecting everything from banks to retail sales to the auto industry. Consumer confidence is hovering at record lows and consumer spending has declined for the first time in 17 years as Americans prepare to ride out what economists think could be the most severe recession in decades.

The first order of business for the new president will be to stabilize the economic crisis.

Plan for Homeowners?

Helping distressed homeowners will be a priority for the new president.

"Just over 1 million households will lose their homes this year in foreclosure," said Mark Zandi, chief economist of Moody's Economy.com.

With one in six U.S. homeowners now "underwater" on their homes -- owing their mortgage lender more than what their home is worth -- this wave of foreclosures is likely to continue, economists say.

Both Barack Obama and John McCain have laid out rescue plans for the housing crisis. Obama proposes a 90-day moratorium on home foreclosures, which would give some homeowners a chance to catch up on missed payments and give the government a chance to develop a systematic plan for rewriting the terms of unaffordable mortgages for qualified homeowners. Obama also wants to empower bankruptcy judges to lower mortgage payments to keep people in their homes, something the mortgage industry opposes.

McCain has proposed a $300 billion mortgage buyout plan, using some of the $700 billion Congress recently authorized to buy troubled mortgages and renegotiate their terms to slow the tide of foreclosures.

Help for the Jobless?

Rising unemployment is another challenge for the new president. As consumers slow their spending, businesses are being forced to lay off growing numbers of workers. Some economists expect the next jobs report, due out Friday, to show that as many as 200,000 Americans were cut from company payrolls in October.

If Obama is elected, he's pledged to extend unemployment benefits and eliminate taxes on those benefits. McCain agrees with eliminating taxes on unemployment benefits. Both also support allowing more leniency on hardship withdrawals from 401(k) and IRA savings accounts, by temporarily lowering or suspending the tax penalties on withdrawals.

Who Will Be Good for Taxes?

Who will pay higher taxes and who will get a tax cut has been a defining issue in this election, with Joe the Plumber becoming a symbol of American fears of "redistribution" of wealth through changes in tax policy.

Obama says he wants to preserve the Bush tax cuts for families earning less than $250,000 and wants to expand tax credits for low-income families as part of his Making Work Pay program.

For families making less than $250,000, Obama supports higher taxes. But he would eliminate income taxes on seniors making less than $50,000 and encourage job creation; he wants to eliminate capital gains tax on small businesses and startups.

McCain says a downturn is no time to raise taxes on anyone. He wants to preserve the Bush tax cuts on income, capital gains and estates. And to stimulate the economy, McCain wants to lower the corporate tax rate from 35 percent to 25 percent.

Cars, Energy and More Jobs

The ailing auto industry will also be a challenge facing the new president. Thousands may face unemployment if General Motors, Ford or Chrysler is forced into bankruptcy. Obama says he supports some aid to carmakers, in addition to the $25 billion loan program approved by Congress in September. McCain has indicated support for the loan program but has not said whether he supports additional aid.

Obama says he would create 2 million jobs by rebuilding the country's infrastructure and he hopes to create 5 million "green jobs" through investment in renewable energy and building out the broadband network to all corners of the country. McCain says by opening up the country to more oil drilling and through the development of alternative energy sources, the nation can create millions of new jobs and reverse "three decades of failed energy policies."

Market Reaction?

And how will the stock market react to the outcome? Many say an Obama victory is already "baked in the cake" on Wall Street. And while history shows that stocks tend to rally the day after a Republican victory and sell off on a Democratic victory, in the long term the outcome of presidential elections is not a reliable predictor of performance.

Like many American voters, traders on the floor of the New York Stock Exchange are just ready for this long campaign to be over.

"I mean enough," said Jason Weisberg of Seaport Securities. "It seems like it's been going for the last four years."

Other Challenges

Kenneth S. Rogoff, an economics professor at Harvard University and a former economist at both the International Monetary Fund and the Federal Reserve, said that the next U.S. president will grapple with a host of issues beyond the recession, such as a wave of retirements by the country's baby boomers that will put increased pressure on government services for seniors.

"Medicare and Social Security are just blowing up and calculations, which used to be long, dated problems, are starting to come to the fore," Rogoff said. The government's Social Security fund, in particular, will have no choice but to turn to deficit spending, he said.

The state of the environment, he said, will also have consequences for the economy in the coming four years. Rogoff said addressing environmental concerns may require new taxes or caps on pollution.

"To actually deal with it has profound economic implications -- that's why we avoided it," he said. "But we can't wait any longer." The president may also have to tackle the disparity in wealth among the country's economic classes, which, until recently, had reached levels not seen since the early 1900s, Rogoff said.

"Although the recent financial meltdown has gone a long way toward ameliorating those differentials," he said, "nevertheless that remains an issue."

The estate or inheritance tax, which generally applies to the very wealthy, is scheduled to be repealed in 2010. It may prove important to the president's work on income disparity, Rogoff said.

"Repealing the inheritance tax was highly questionable in terms of income distribution and the president needs to address issues like that," he said.

Social Security

Kent Smetters, a professor at the University of Pennsylvania's Wharton School and former deputy assistant secretary of economic policy at the U.S. Treasury, said that the largest economic issue facing the next president is the "looming entitlement programs."

Smetters said the problems with Social Security, Medicare and Medicaid are much larger in magnitude than the fallout from the subprime housing market and the government's bailout of Wall Street firms.

That bailout, he said, "is just an appetizer for the real deal to come."

He said the problems with these programs today are "much bigger" than what past presidents have faced.

"We've waited so long. You can't possibly increase taxes enough to deal with this problem," Smetters said. "We've actually exhausted all of our black powder at this point in terms of tax increases."

Next up, Smetters said, the president should work to cut the corporate tax rate.

"It's just not sustainable," he said. "We now have one of the highest statutory rates in the world."

India and China have a fast-growing middle class that now has money to invest. "It's going to be a lot less attractive for those countries to invest in the United States and for Americans to keep their money here," he said.

Keeping the tax rate at its current level would hinder investments and growth of our economy, Smetters said.

The third big economic area for the new president -- and Smetters emphasized that it was the third most important -- is the government bailout.

"In my opinion it is a far distant third," he said.

There is going to be a regulatory tangle administering the program and a call for a whole new set of oversight regulations for Wall Street.

But the key, says Smetters, is for the new president to determine what type of precedent the bailout sets for future businesses and investors.

"Does it allow," he said, "for entrepreneurs and corporate executives to game the system?"

A Global Economy

Lewis Alexander, chief economist at Citigroup Inc., sees a very significant set of economic challenges for the next president.

One key issue for the next president will be "getting the financial system back so that it is actually contributing to growth," he said

"In the last four weeks the situation has moved from what was a U.S. issue to a global issue, impacting emerging markets," Alexander said. Firstly, "the economy is contracting quite sharply, that would be challenge number one. The expectation is that the economy is going to be contracting through the middle of next year, with mild growth following that."

"The floor is just falling out from under, you saw that last week in the consumer confidence number," he said. "A lot of headway has been made with the [Troubled Asset Relief Plan] and other programs but that has yet to be played out."

Alexander said that when Bill Clinton took office in 1992 and when Ronald Reagan took over in 1980 they faced a sort of cyclical challenge that is not the acute problem in the financial and global sector that is seen now.

"Inevitably whoever wins is going to have to focus on getting the economy going. That inevitably means they are going to have to rein in their priorities," Alexander said. "Both candidates have focused on health care and despite what has gone on economically, I think that focus will continue because unless you get your arms around that it's going to be hard to make the long run work."

"If the economic situation weren't so bad you probably would have seen Obama and likely McCain come out with a big health-care push early on in the administration," he said. "It probably won't be that soon now but I think they will try to make a run at it."

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